How microfinance companies operate

QUESTION: I read a response you wrote on the Internet which I must say was very informative. With regards to the topic of "small lending agency", it's something I am really looking into! Based on the article, on the other hand, I get the feeling that you don't think it's a good idea. My questions to you are:

1. Can a small lending agency have both secured and unsecured loans?

2. Does the lending agency act have specific laws surrounding the requirements for both the lender and the borrower to abide by? If so, what might those be?

- Jason

PFA: My column of April 10, 2011, to which you seem to be referring, addressed specifically the questions raised by a specific reader, so my response is not to be seen as a verdict on the microfinance business generally. In fact, although it clearly is not suitable for some persons, there is no reason to believe it cannot be a suitable and highly profitable business for others.

Before answering your questions, I am suggesting that you satisfy yourself that you have the necessary capital to set up such a business, that you are prepared to establish a formal business by incorporating it, for example, that you do adequate, sound market research, and that you are equipped to set up the structure for managing and operating such a business.

Although there is not a body that regulates the microfinance market, the Moneylending Act sets the framework for how it operates. You should bear in mind that the microfinance market includes some of the large financial institutions as well as small, independent businesses, but the act exempts many of these institutions and others from its ambit.

Low risk

The small businesses in the microfinance market grant both secured and unsecured loans, but they do not expose themselves to the risk of not being able to collect. They, for example, require that borrowers are in the employ of a reputable company, that borrowers and guarantors provide suitable forms of identification, and that loan payments are made by way of salary deductions from "approved" employers in some cases.

Because the Moneylending Act governs money- lending transactions in Jamaica in respect of those persons or entities that fall under its provisions, both lenders and borrowers are required to abide by them.

Non-compliance with the provisions of the act that set out the form that moneylending contracts are to take can form the basis for a court to set aside a contract purporting to be drafted pursuant to the act. In order for a contract to be enforceable, it must be in writing, signed personally by the borrower, contain the date of the loan, the amount of principal, and the rate of interest per annum. The contract must be signed by the borrower before the money is lent or the security given.

In some cases where the contract does not fully comply with the provisions above, it is possible for an application to be made to the court which may declare the contract to be enforceable in the same way and to the same extent as if all requirements have been complied with.

The Moneylending Act provides significant protection to borrowers. One clause provides for the court to rule that a lending rate is "excessive" if it exceeds the prescribed rate. There are also penalties for lenders who use false, deceptive, or misleading statements, or who use fraudulent means to induce or attempt to induce a person to borrow money or to agree to the terms on which the money is borrowed. Lenders are also required to supply information on the state of the loan and to supply copies of related documents.

Borrowers are expected to repay their debts, but the act prohibits the charging of compound interest or the rate of interest being increased by reason of default in the payment of sums due under the contract.

If you have what it takes to enter the microfinance market, enter, but bear in mind that there are rules that apply to the lender and the borrower, and that success depends heavily on the practice of sound business principles.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of "The Handbook of Personal Financial Planning", offers free counsel and advice on personal financial planning.Email: finviser.jm@gmail.com